Impact of Oil Prices on Unemployment

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25th Jul 2017 Economics Reference this

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The dependence on oil has increased in many nations as a result of increasing industrialization and oil has been the factor of many crises as well as many wars. However, this assignment examines how the oil price shocks affect the unemployment rate. Our main objective is to see whether a change in the oil price will affect a change in unemployment rate at a later stage.

Oil price plays a very important role in an economy of every country. Oil is the main commodity that generates growth in an economy. Oil price fluctuation cause many problems in an economy such as high inflation, unemployment, and decline in GDP (Ling&Jones, 2011). Oil price increase can also contribute to an increase in the cost of production, which effects the number of employees. Industries are dependent on oil. An increase in the oil price will have major effect on production (Mellquist&Femermo, 2007). A higher cost of production because of a surge in the price of oil can cause people’s rate of consumption to decrease. Employee is also dependent on aggregate demand or people consumption. A reduction in demand also contributes to higher unemployment. In short, oil price shocks can increase the marginal cost of production in many industrial while reducing the production and thus increasing the unemployment.

In 1998 Alan Carruth, Mark Hooker & Andrew Oswald (C, H&O) modified the Shapiro & Stiglitz (1984) model by adding a role for input prices to create an equilibrium unemployment model (Carruth, 1998). In the C, H&O equilibrium unemployment, U*, is a function of five variables, as shown in the following equation:

U*=U*(r,Po, b(µ), e, d); Where,r= interest rate; Po= price of oil; b(µ)= level of unemployment benefits; e= on-the-job effort; d= probability of successfully shirking at work

According to the model, an increase in any of these five variables has a positive effect on U*, all else equal, with the exception of an increase in d, which has a negative effect. According to their logic, an increase in the price of oil will lead to less profit for the firms. To get back to zero-profit equilibrium one of the variables has to change, since interest rates are largely fixed internationally, the price of labour has to alter. Considering unemployment and wages to be connected inversely by a no-shirking condition, equilibrium unemployment must rise. This is the only thing that will make the workers accept a lower salary. This is how the oil price shocks affect the unemployment rate.

Besides that, from the seemingly contradictory evidence of macro and micro data, James Hamilton conclude that if the price of oil does not fall, the consumption of each consumer also will exceeds it so if the consumer spending increases by $ 1, the producer’s spending is reduced by $ 1, which is not really net economy. In 1988, James Hamilton mentioned a model is the decline of the oil price will increase the unemployment rate of the each oil industry sector such as the oil industry sales and service, and more in turn who sell to these suppliers (Hamilton, 2016). In addition, the oil industry developed two new oil drilling technologies-horizontal drilling and hydraulic fracturing. It affected the cost of the oil production become higher and this technologies can instead of labour. Therefore, some of the oil industry in order to avoid higher cost of production so they will reduce the number of workers and it will cause in the unemployment of oil workers (Wolla, 2015).

According to Camilla Knudsen mentioned that the unemployment spikes as drop in oil price hits the economy of the country. In July 2014, Norwegian unemployment jumped to a 10-year high and this situation directly affected the economy of Norwegian. The Norwegian government has proved the oil prices have dropped from more than $100 per barrel to $43, it damaged the investment of  Norwegian and increased the unemployment rate by more than one third in the same period. These are global economic instability, the bad economy of Norwegian increased the unemployment and affect the oil prices fell (Knudsen, 2015). For example, there was crude oil price volatility on unemployment in South Africa from 1990 to 2010 (Phakama, 2015). South Africa is a major importer of crude oil and suffers a problem of presistent high levels of unemployment. When the price of Brent crude oil increased from $23.43 in 1990 to $79.54 in 2010, the unemployment rate of South Africa also increased from 18.8% in 1990 to 24% in 2010 (Heydova et.al, 2011). The increased in the price of Brent crude oil was cause by the traced in the global economy and OPEC’s output decisions. According to Phakama (2015), crude oil prices are positively related to unemployment in South Afica.

Furthermore, Andreas (2009) claims that there is a significant unemployment response about three months subsequently to a respective oil price shock in Germany. This may because of the labour market of Germany is still very dependent on the situation of the oil market. According to Hamilton’s (1996), the net oil price increases significantly does affect the unemployment rate in post-unification Germany. This is because when the crude oil price increases, the cost of production for the firms will increase. Hence, they will cut down the amount of workers to decrease the cost of the wages and in the end the unemployment rate increase.

Our main finding is that rising oil price leads to a decline in real wage in all sectors of the economy. These changes wages fell sharply in every industry and within each industry by skill level. At the aggregate level most of industries, all workers’ wage cut following oil price rose but the relative wage of skilled worked tends to rise. This is the skill premium rises after the increase of oil price. In addition, our results show that the changes of labor structure cause the oil price shocks. Therefore, using panel data econometric techniques unnoticed workers right heterogeneity is essential consistent estimates of the impact of oil price shocks skill premium (Keane and Prasad, 1996). We found that the oil price increases reduce employment in the short run and industry employment shares in the long run. However, the long-run effect on aggregate employment is negligible, possibly indicating substitution between energy and labor in the aggregate production function. These results provide some support for the sectoral shift models of unemployment of Lilien(1982), Hamilton (1998) etc. Hamilton ‘s model states that even through the energy inputs account for a rather small fraction of total input costs, the price changes may cause a lot of frictional employment in the short run as labor is reallocated department in the response to relative productivity changes. An additional prediction of sectoral shift models is that workers would tend to move towards those sectors where the relative productivity of labor ( reflected wages) increase following a real shock.

In conclusion, we found a relationship between the oil price and unemployment changes. Oil price shock it would spread to other major sectors of the economy (Liang,2008).Oil price shock would cause unemployment rate increase lead to decrease the real wages, consumption, and welfare of all households groups. While implementing a climate policy without and with an oil price shock leads to a welfare gain for the rural and urban household. Higher unemployment government faces with pay more unemployment benefits and issuing more stimulus payments (Tverberg, 2013).Governments influence by the high cost of replacing infrastructure set up the alternative of asphalt road cost is much higher.  The climate policy scenario also leads to the redistribution of resources and change the industry’s output. For example, the production factors shift from crude oil, natural gas, cement and iron and steel sectors to services sectors. Lastly, most important point is a need to create awareness among people about the importance of the natural resource, how precious natural resource are for us and for our future generations. People should be aware crude oil is very limited inside earth and it is non-renewable resource, so it is our responsibility to keep it for our future generation and should use it as minimum as possible (Tverberg, 2013).

References

liang, chai (2008) Impact of high oil prices on the Malaysian economy. Retrieved from https://cloudchronicler.net/2008/09/27/impact-of-high-oil-prices-on-the-malaysian-economy/

Keane, M.P. and Prasad, E.S. (1996) ‘The employment and wage effects of oil price changes: A Sectoral analysis’, The Review of Economics and Statistics, 78(3), p. 389. .Retrieved from

https://www.minneapolisfed.org/research/dp/dp51.pdf

Tverberg, G. (2013) Ten reasons why high oil prices are a problem. Retrieved from

https://ourfiniteworld.com/2013/01/17/ten-reasons-why-high-oil-prices-are-a-problem/

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